Scottrade Offers Low-Cost, Commission-Free Focus Morningstar ETFs

Update: As of late 2012 Scottrade announced that they would liquidate their FocusShares ETFs.

Scottrade bought FocusShares as a subsidiary and has joined the free ETF landscape. They introduced 15 new low-cost Focus Morningstar ETFs which passively track several major broad indices. Discount brokerage Scottrade will allow account holders to trade them commission-free without any holding limits or additional requirements. You don’t need a certain balance, and you could trade as little as one share at a time. Here’s a list of the ETFs:

Focus Morningstar US Market Index ETF (FMU)
Focus Morningstar Large Cap Index ETF (FLG)
Focus Morningstar Mid Cap Index ETF (FMM)
Focus Morningstar Small Cap Index ETF (FOS)
Focus Morningstar Basic Materials Index ETF (FBM)
Focus Morningstar Communication Services Index ETF (FCQ)
Focus Morningstar Consumer Cyclical Index ETF (FCL)
Focus Morningstar Consumer Defensive Index ETF (FCD)
Focus Morningstar Energy Index ETF (FEG)
Focus Morningstar Financial Services Index ETF (FFL)
Focus Morningstar Healthcare Index ETF (FHC)
Focus Morningstar Industrials Index ETF (FIL)
Focus Morningstar Real Estate Index ETF (FRL)
Focus Morningstar Technology Index ETF (FTQ)
Focus Morningstar Utilities Index ETF (FUI)

Tracking Indexes
It’s a bit annoying that all these guys track a proprietary index from Morningstar. For example, the US Market Index ETF tracks the Morningstar® US Market Index, the Large Cap Index ETF tracks the Morningstar® Large Cap Index, and so on. I know they probably end up very close to other broad indexes, but it makes performance comparisons more difficult. Perhaps they really wanted the Morningstar brand on them, or maybe the licensing fees are a lot cheaper than MSCI or S&P charges? Maybe both.

Expense Ratios
One of the major attractions of these new ETFs are their super-low expense ratios. In most cases, they are the cheapest in their sector, even lower than Vanguard. The US Market Index ETF charges a mere 0.05% annually. They provide a ETF expense comparison chart.

However, Vanguard’s structure has them offering ETFs “at cost”, which means that employees are getting paid, but there are no profits going off to eagerly waiting shareholders. Vanguard’s US Market Index ETF (VTI) is huge with nearly $20 billion in assets, and they are charging 0.07%. There is absolutely no way Scottrade & Focus are making money on these things at 0.06%, somebody is subsidizing the heck out of them and will be losing money for a while. If these don’t do very well, then they will either shut them down or raise expense ratios in the future.

Would I Buy Them?
First, competition is good, and I’m happy that people are realizing that costs do matter. If you really wanted exposure to these areas and already have a Scottrade account, this does makes them very convenient. You can open an account with just $500, and there are no minimums or maintenance fees. I can see how Scottrade-affiliated financial advisors would like them, as it lower costs for clients already committed to the platform, and they can rebalance without commissions.

There are similar free ETF offerings from Fidelity, Schwab, and TD Ameritrade

If you are an individual investor buying ETFs as a long-term holding, my preference would be to open an account at Vanguard, buy their ETFs with no commission as well (or mutual funds), and be able to feel confident that your costs will always remain reasonable. They also have a much wider selection, including international stocks and bond funds. FocusShares already shut down all their ETFs once back in 2008 already. Are these added risks worth $2 a year for every $10,000 invested?

More coverage: IndexUniverse, WSJ.

Comments

  1. Bryan Rink says:

    Today’s price range on FMU (US Market Index) is 15.43 to 25.40. Looks like they still have some kinks to work out.

  2. My wife’s ROTH is with Vanguard, and we really like their low fees but quality products.

    We try to diversify a little though, so my ROTH is with T Rowe Price. They aren’t as inexpensive as Vanguard, but still pretty good and I’ve liked their funds as well.

    Maybe its paranoia, but I try to spread out my funds a bit between companies. Since these investments aren’t FDIC insured, I’d hate to have all of my money with one mutual fund company, and then some weird thing happens and they go out of business, turns out they’re a scam, etc.

  3. First, I’m a big fan of your blog, and kudos for beating most others to the punch on this latest development. That being said, please keep my critique below in the spirit it’s intended (constructive).

    I’m not sure if I understand your complaints under “Tracking Indexes.” First, all indices that index funds track are proprietary, whether they be owned by S&P, Wilshire, Russell, MSCI, Schwab, Wisdomtree, FTSE-RAFI, or Morningstar. Second, how does the use of a Morningstar index make comparisons more difficult? One should be able to compare the funds’ performances to their underlying indices for tracking error, and to other ETFs for factor purity or whatever happens to concern you.

    What bugs me about the move are: (1) Why launch new unknown ETFs when they could have partnered with State Street? (2) At least the initial offerings seem more targeted to day traders rather than buy-and-holders–Who needs a “consumer defensive” sector ETF rather than a bond or international large-cap offering?

  4. @Bryan – They are just starting out, so also low trading volume can make their bid/ask spread pretty wide. I should have also mentioned that.

    @Anthony – You’re right, of course, that they are all proprietary. I just mean why another new proprietary index? I would think that making an index fully investable and properly constructed for actual ETF structure would be a skill, and I don’t see why Morningstar would be especially good at it. Seems like just a popular brand name.

    IMO, I don’t care as much about how it follows whatever index as much as total performance over time. If I buy a total stock market ETF, I want it to track the US market without excess trading and proper index sampling. Those things would affect performance, I think. Now, if performance differs, is it because of indexing skill on their part as managers, or is it because the index is just constructed differently?

    Your point about too many sector ETFs is also very good. I guess that’s where they think the money is.

  5. @Jonathan:

    Point taken. It reminds me of Vanguard’s switch to (and involvement in the construction of) the MSCI domestic indices a few years back. Ironically, that switch from S&P/Barra to MSCI for the small-value index led to me preferring a non-Vanguard fund in that space, but that’s for another day (and is probably dancing on the head of a pin).

    I do wonder how new the M* indices are. I think their broad market and cap-based indices have been around for a while, but I don’t know about the sector indices.

    It will be interesting to see whether Scottrade is able to attract enough assets to these new funds with their pitch to traders (between the sector fund emphasis and the “no holding period” to contrast themselves with TD Ameritrade) to then expand into more buy-and-hold territory (bond, broad international, and of course I’d like to see small-value).

  6. I have a Scottrade account and these ETFs look compelling to me.

  7. sacundim says:

    @Justin: Mutual funds and ETFs aren’t FDIC insured, but they’re very different creatures than bank accounts, and don’t have the risks that FDIC insurance covers.

    Remember, a bank is a business that takes $100 deposits from 10 people, and then lends $800 to an eleventh person. If all of the 10 depositors came and asked for their money at once, the bank would fail, and that’s why there is FDIC insurance—even the best-run bank cannot survive that.

    A mutual fund takes $100 from 10 people, buys investments with that $1,000, and leaves them in the care of a third-party custodian. The value of those investments may fluctuate, but there is no “fund run” scenario that can cause a well-run fund to fail like a bank can.

    Also, the fund company doesn’t own the funds; it only manages the fund. The shareholders of the fund own the fund. The assets are held by a third-party custodian, never by the fund manager directly. If the fund company fails, the fund shareholders still own all of the assets; they’d have to find another management team for the fund.

  8. I am an RIA with a large percentage of my assets custodied at Scottrade. They were forced to make this move to stay competitive with Schwab, Ameritrade, and other popular adviser platforms. Competition is nice. Like Schwab’s but unlike Ameritrade’s, Scottrade’s commision-free ETF offerings are brand spankin’ new funds. It will take time to build volume. Until then don’t use market orders. Unless you enjoy selling a $25/share fund for $2/share (which happened to some unlucky and unwise traders on the first day of trading; the sales were eventually broken by the exchange).

  9. Regarding the many comments above about the indices tracked by the ETFs:

    There is a potential tax advantage that arises because the Scottrade ETFs track a different index than the comparable funds from iShares and others. It is esoteric and admittedly remote, but some here may find it interesting so I’ll mention it.

    When tax loss harvesting, one generally wants to sell a losing fund while maintaining the same market exposure. You can’t buy back the same fund or the generated loss will be disallowed under the wash sale rules. An alternative approach is to buy a different fund that tracks the same index. This MAY avoid the wash sale rule but it’s unclear. As far as I am aware the IRS has never imposed the wash sale rule on two different funds, but if you’re the unlucky test case, you would be in a much stronger position if your funds track two different indices.

    For most investors this is much too remote to worry about, and I agree. However as an investment adviser and tax lawyer, I have to worry about it. Even though remote, the cost of falling afoul of the wash sale rule could cause a big client to take his business elsewhere. So I play it safe by tax loss harvesting across funds tracking different indices. Scottrade’s new fund family represents another tax loss harvesting option.

  10. So much for the free Scottrade ETFs. They just closed them down last week. I enjoyed using them and made some profitable trades. Oh well, time to look elsewhere since I hate paying commissions.

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